The Conundrum Of Taxing IPR: The Achilles Heel Of Taxation Regime In India

[By Brahm Sareen

The author is a student at the University school of law and legal studies, GGSIPU. 

Introduction:

Recently, the multinational corporations (hereinafter referred to as “MNCs”) operating under the franchise agreement in India started facing scrutiny by the taxman over the royalty income which is a part of their intangible assets. These MNCs operate in India by allowing the Indian companies to operate their subsidiaries in their global brand name. With the growth in the transfer of these intangible assets, the states naturally started taxing these transactions making them a part of the broader economy[1]. However, in the past, these transactions had sparked controversy over the taxability of intellectual property rights (hereinafter referred to as “IPR”) in India. The conundrum of whether to categorize intangible assets as sale of goods or services along with defining the nature of the agreement remains unresolved.

A recently similar question of law was dealt with by the Hon’ble High Court of Punjab and Haryana in a writ petition filed by Subway systems in India against the tax authoritie. In this case, Subway alleged that the Indian Taxman, without issuing an advance ruling notification, issued various summonses over the non-payment of taxes on their intangible assets and royalty. The question remains the same, as to whether MNCs be taxed on their intangible assets under the right to use, or the transaction be treated as a transfer of right to use or “deemed sales”? Therefore, delving into the aspects of the current IP taxation regime in India is important as the Indian taxation regime deals with these transactions differently.

IPR tax regime in India:

Before the advent of GST reforms in the taxation regime of India, there lies a long-drawn debate on the assignment and licensing of intangible property. However, a well-defined jurisprudential aspect in the IPR taxation regime still lacks as irregularities and discrepancies were all left on the judiciary to decide. In this sense, it is important to define an intangible property to further categorize it and identify the nature of the agreement and the transaction involved.

According to section 2(11)(b) of the Income-tax Act, 1961, intangible assets include “know-how, patents, copyrights, trade-marks, licenses, franchises or any other business or commercial rights of similar nature” excluding goodwill of a business. Delving into the question of whether these assets are goods or services, the CGST Act, 2017 shall be referred. According to section 2(52) of the CGST Act, 2017, goods include all types of moveable property other than money and securities. Going by this definition it is safe to assume that the supply of any moveable property is a supply of goods.

In Tata Consultancy services vs. the State of Andhra Pradesh, the Hon’ble Supreme Court held that intangible assets can be called goods if they are capable of being abstracted, consumed, used, transferred, delivered, stored, or possessed. While on the other hand according to C.B.E &C Circular No.80/10/2004-S.T dated 17.09.2004, temporary transfer of IPRs will be termed as intellectual property services while the permanent transfer of such rights cannot be termed as service. This is because the holder of the intellectual property will no longer hold it in his/her possession and therefore, it will be dealt as sales of the intellectual property. This position of law is also defined by Section 66E(c) of the Finance Act, 1994 which states that temporary transfer or enjoyment or permission to use an IP is a part of services excluding permanent transfers of such property. Accordingly, if the intellectual property is dealt as goods then the transfer of such goods will be deemed sales according to article 366(29A) of the Indian constitution. The position of law, therefore, before the application of GST in India was based on the interpretation of the nature of the transaction, however current regime too has failed to give a conclusive end to the problem of taxability.

Licensing v. Assignment

Much of the debate on the rates of tax to be imposed on MNCs boil down to the nature of the transaction involved. Particularly, the argument lies in the categorization of such transactions. It is not the first time that this question of law is argued. For one reason, it can be sufficiently derived that the jurisprudence before GST had enough debate on the same. One such example is Commissioner of Sales Tax v. Duke and Sons Pvt. Ltd. While this case enumerates the difference between licensing and assignment, the same is ridiculed the moment it distinguishes the transfer of a trademark from the assignment of the same further stating that “permission in writing as required by law may be enough” to suffice transfer of a trademark. The whole jurisprudence behind the concept of “deemed sales” was reduced to permission in writing in this one single sentence. Further, the proposition in its judgment which distinguished assignment and transfer of right to use were against the settled position of law. Something to which an attempt was made by the court to reverse the same in BSNL vs. Union of India which had set out a clear test of exclusivity to identify the nature of the transaction. The BSNL judgment though has been rendered irrelevant with the advent of GST as tax is concurrent now, still laid down the exclusivity test that can be still applied.

The Duke judgment as a whole gave a clear description of what the difference between assignment and licensing. It was held that the assignment of a trademark would mean the proprietor would be divested from his right to use the trademark whereas the same would not be the case in-licensing of a trademark. A license per se is an assurance to the licensee that the owner or the proprietor of the asset won’t initiate any legal proceedings against him if he uses the same. On the other hand, the assignment of an asset would simply mean the right over the asset being transferred to the assignee either wholly or partially. Where section 19 of the Copyright Act, 1957 treats the assignee as the owner of the asset, and a plain reading of section 45 of Trademark Act, 1999 clears the air that the assignee becomes the proprietor of the assigned trademark, the court simply failed to interpret the legislative intent.

Current position

Recently, the 45th GST Council made the recommendation to increase the applicable tax rate for the permanent transfer of intellectual property rights in respect to goods from 12% to 18% vide Notification No. 13/2021-Central Tax (Rate). Earlier the rates applicable to the permanent or temporary transfer of IPR in respect to the supply of goods were 12% other than IT software which was taxed at 18%. However post the notification, the separate tax rate for IT software has been omitted and the supply of goods is now taxed at 18% GST. This means that the permanent transfer of goods and services is now taxed at 18% GST. This is a clear case of nomenclature and disputed territory as a consequence. The phrase “permanent transfer” was not deleted from the service notification, however, was inserted in the notification of the goods creating a quandary as to the applicability of rates. This problem has not been resolved with the amended notification rather only the applicable rate has been increased.

Are franchise services the same as licensing services?

The question of whether the franchise model would be dealt with the same applicable taxes like that of licensing services under Serial No. 17, Heading 9973 mentioned in Notification No.11/2017-Central Tax (Rate) dated 28.06.2017 is of utmost importance in the present writ petition filed by Subway. This question has been answered in an Advance ruling by Gujarat AAR GST in In re Tea Post Private Ltd. In this ruling, the AAR of Gujarat had faced a question of whether the franchising services and royalty fees would come under the ambit of Heading 9973 attracting the applicable rate of GST at 12% or would be dealt with differently under other headings. The applicant was a tea house chain under a franchise agreement with a third party under the brand name “TEA POST” who thereby submitted that the franchise fees and royalty is covered under heading 9973 and service code 997336 as per the scheme of classification of services. The AAR ruled that licensing and franchising shall be dealt differently. It stated that licensing implies that the ownership would remain with the licensor however the same cannot be stated in the case of franchising. In franchising, the ownership is enjoyed by the franchisee in “lieu of fee where the processes are controlled by franchisor”. Therefore, the AAR held that the nature of the agreement is of franchising than licensing. As a consequence, the applicable heading shall be Serial No. 21 Heading 9983- other professional, technical and business services and service code (Tariff) No. 998396 as “Trademarks and franchises”. The tax rate was decided to be 18%.

The ruling by Gujarat AAR has a lot of significance in the subway’s case. Subway like any other multi-national food outlet operates on a franchisee model. Therefore, the agreement cannot be dealt with in the same manner as that of licensing. This would directly impact the attracted GST rate in the present writ petition. Even though this does not justify the taxman’s conduct of heavy scrutiny towards businesses operating on franchisee models, this does make a case for the taxman to justify the rate of 18% under Heading 9983.

This was not the first time Subway faced a conflict of this nature. In the case of Subway Systems India Pvt. Ltd. vs. the State of Maharashtra, the conflict of whether the franchise fees and royalty would be taxed under VAT demanded by the tax authorities had arisen. However, the judgment was held in favour of Subway wherein the Bombay High Court held that mere inclusion of franchises under the MVAT act would not attract VAT and the nature of the agreement has to be analyzed. Even though the indirect taxation system in the pre-GST regime was not a settled position, various courts time and again held that franchise agreement gives mere permission to the franchisee to use the trade name or brand name and is a “representational right”.[2] Therefore, the taxman’s argument stating that franchise fees and royalty shall be categorized under transfer of right to use is both unsupported by law and reason.

What does an increased GST for MNCs mean?

The conundrum of taxability of intangible assets has created apprehension for MNCs operating in India. For one reason, MNCs believe that the franchisee business operated by them is full of risks and uncertainty owing to India’s transitory and unsettled tax laws. Therefore, MNCs try to avoid taxes through practices such as IP structuring, debt-shifting, and Transfer pricing. This puts the Indian tax authorities in apprehension of potential losses. While IP structuring is one of the common practices where MNCs register their intangible assets in low-tax countries, the same is one of the main causes of scrutiny towards MNCs by the authorities in India

However, this could mean that the Indian economy, which is still recovering from the pandemic, would be facing more problems with taxman’s hard scrutiny towards multinationals. This conduct will further invite procedural complications and ambiguities. As of now, it seems that the multinationals are in murky waters of uncertainty and the Indian taxman is on a hunt. This worsens the already worse situation the Indian economy has been in ever since the pandemic. To ensure secured investments, the agreement on setting up a global minimum corporate tax rate on MNCs would help India survive.

[1] Balaji Subramanian et al., Bottling Fame, Brewing Glory and Taxing the Transfer of Intangibles, 11 NSLR, 223, 224 (2017).

[2] MC Donalds India Pvt. Ltd. v. Commissioner of Trade and Taxes, New Delhi, 2017 SCC OnLine Del 8414.

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